Understanding The Main Consequences of the Debt Crisis

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ForexNewsNow – As Forex markets, and the EURUSD pair in particular, are more volatile than ever, the sovereign debt crises both in Europe and the US may directly result in the lowering of credit ratings of additional countries by the major credit rating agences. In Europe for instance, the northern countries could be affected by the southern countries’ situation since they are currently financially supporting them via the European Financial Stability Facility (EFSF). This may lead the credit ratings of northern European countries to be downgraded as well.

In the UK, GDP growth is extremely weak (less than 1% in 2011) and it will be very difficult for Prime Minister David Cameron’s government to cut the public deficit. For these reasons, the credit rating of the UK may also be lowered sooner or later.

Lastly, in the US, no solution has been found to completely draw down the public debt and forecasts are very pessimistic.

In the absence of a credible plan to balance the budget, the US credit could be downgraded again in the future.

Global consequences

The US Public Debt is so massive that it is difficult to conceive that all non-US creditors would abandon it. What is more likely is a diversification of investments towards safe havens (and away from the US dollar) such as the Yen and Swiss Franc, which should strengthen them drastically, as we observed with price of gold in the last few years:

Following these trading trends, the treasuries market may decrease in importance until a new major currency emerges. Natixis expects both a progressive depreciation of the Greenback and a risk premium on US debt, which may lead to a rise in the long-term interest rates.

Lastly, inside the European Union, if countries really want to avoid the collapse of the euro, northern countries will have to increase their aid to southern ones using different means such as the EFSF or Eurobonds. This increased cooperation may lead to a convergence of interest rates in the euro zone.

Conclusion

These developments should not be understood as risks, but rather as potential opportunities for Forex and other financial traders. However, they will only come to fruition if the right measures are taken by political leaders. Restarting growth despite the growing number of emerging countries is not impossible for Western economies, however it requires one to accept and confront the hard reality of the current global debt crisis now.

By ForexNewsNow Team

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